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July 24, 2013

How to Capitalize on Three Emerging Macro Trends

Salient Partners sees three trends over the next 10 years on which it’s positioned well to capitalize on

Houston-based Salient Partners is doing some cool things in the alternative space, and Lee Partridge, the firm’s chief investment officer, is more than happy to tell you about them. But first, Partridge provides some context.

“We see three big trends over the next 10 years which we’re positioned well to capitalize on,” he says. “The first is that we’re still in a deleveraging economic environment, and ultimately we will have to reduce deficit spending.”

“The second theme is the run-up in energy production in North America,” Partridge explains. “Production is now up 30% from where it was in 2010 and we’re still three years from catching up with supply to meet demand.”

The third and final trend is the demographics of developing nations, specifically workers and retirement.

“What’s happening in developed nations is the opposite of what’s happening in emerging nations, and the latter is sitting on a strong supply of natural resources.”

So how is the firm taking advantage?

In energy, Salient’s platform creates “diversified return streams,” specifically in the (what else?) mid-stream MLP market. The firm also offers trend-following and risk parity strategies, the former of which he claims is “one of the best diversifiers to traditional portfolios.”

As to the latter, Partridge points to a recent white paper the firm produced titled, “Risk Parity in a Rising Rates Regime.”

“There are entirely sensible reasons to have long-term concerns about bonds in light of current interest rate levels, and given the historical tendency of risk parity strategies to have large positions in bonds, the concern for risk parity in a rising rates regime is understandable,” the white paper concludes. “Evidence from the last rising rate environment indicates, however, that critics of risk parity potentially understate the potentially diversifying influence of commodities in these periods, the responsiveness of risk parity strategies to changes in asset volatility and the dynamic incorporation of changing correlations in many risk parity implementations.”

Um … what does it all mean?

“From our analysis of a typical portfolio in the 1970s (the last period of sustained rising interest rates), we found that adding momentum to risk parity improved performance to where it dominated a traditional 60/40 portfolio.”

Partridge notes two other strategies the firm is using to capitalize on the three trends, strategies that thankfully don’t require quite as much explanation.

“Our alternative beta is negatively correlated to equities, so when they’re down the alternative beta performs very well. And it’s much cheaper than tail-risk insurance. Finally, our global equity fund is there to specifically take advantage of what we talked about in emerging markets.”